Steel in China

Lovingly touched by Mao

A huge steel market that offers little for its own producers

THE world's two biggest consumers of steel, China and America, appear to have much in common. In both countries, steel mills have been going bust, making losses or, at best, meagre profits. And in both, the industry is asking for protectionism to buy time and consolidate.

In one key respect, however, the two markets could not be more different, and it is the larger, China, that represents the best remaining hope for an industry suffering globally from sluggish growth and a capacity glut. Why? Because not only is China's demand for steel growing furiously, but its domestic industry is in such a shambles that it will not be able to supply the country's needs for years to come.

In the two decades since China embarked on market reforms, its steel consumption has quadrupled. In 2000, China passed America as the world's largest market. But that is only the beginning, says Jonathan Woetzel of McKinsey in Shanghai. China still consumes only 92 kilograms per head each year—far less than other developing countries like Malaysia, which uses 450 kilograms per head. Even if that gap is only partly closed, Chinese demand should double during this decade.

A boon for Chinese steel makers, then? Unlikely. Steel has always been a favourite with central planners, but Mao Zedong had a particular fetish for it. In the 1950s, millions of abjectly poor Chinese were encouraged to contribute their tools and other metal possessions to the smelters, so that China might “catch up” with developed countries in production. In the 1960s, Mao decided that each region was to be self-sufficient, and hence should have its own steel mill. Steel was the last sector to emerge from central planning, four years ago. Even today the industry, which employs 3m workers, remains in the clutches of party politics.

The result of all this is three big problems. The first is fragmentation. China is dotted with 1,042 steel mills, 95% of which make losses. The second is thus inefficiency. The average Chinese worker made 41 tonnes of steel in 1999, according to Pitzi Lau, an analyst at Salomon Smith Barney; his counterpart at South Korea's POSCO (now the biggest steel maker in the world) made 1,362 tonnes. The third problem is that China's mills are good at pumping out lots of steel of the type that nobody wants.

The government's intended solution for the first two problems is consolidation. Since the mills are state-owned, merging them is not difficult. Reaping the benefits from mergers, though, is tricky, since laying off all excess workers at once is impossible. The national champion, Baoshan, a product of several mergers, is barely profitable and remains a dwarf compared to steel makers in other countries.

Solving the wrong-product problem is proving just as difficult. The central planners have left China well equipped to make the long steel bars used in buildings and railways. These are easy to make, but there is little money in them. More attractive is the market for the sophisticated sheets used in cars and computers. These products, however, require technology and skills that the Chinese never bothered to acquire. So China has to import them.

So far, this has been good news mostly for the big steel exporters in Japan, South Korea and Taiwan, which together account for two-thirds of China's imports. As America's economy went into recession last year, and as the Bush administration began considering new tariffs to protect American steel makers, Asian giants such as POSCO and Japan's Nippon Steel absorbed some of the shock by diverting even more exports to mainland China.

China's recent entry into the World Trade Organisation helps too. Membership commits China to phase out tariffs on most steel products by 2004, with half of those cuts due this year. This is good for China, which will be able to industrialise more cheaply. But it makes life more difficult for China's steel industry. The government now hopes that foreigners will not only export to China, but also invest in it. Some western steel makers, such as ThyssenKrupp, already have joint ventures in China, usually near the Chinese plants of customers from home, like Volkswagen. In time, this infusion of capital and knowledge may even turn one or two of China's steel makers into world heavyweights.